Fix Medicare's Bizarre Auction Program (New York Times Blog)

The New York Times Freakonomics blog post in 2010 titled, “Fix Medicare’s Bizarre Auction Program,” discusses in detail the flaws of the current Medicare competitive bidding system and how “Medicare should junk the flawed procurement auction rules and take advantage of the enormous advances that have been made in auctions and market design to fix the auction rules.” Here are several passages:

NY Times Freakonomics Blog

September 30, 2010

Fix Medicare's Bizarre Auction Program

By Ian Ayres and Peter Cramton

"Economists and other auction experts agree that using administrative prices from 25 years ago to set Medicare prices is a bad idea, and that a much better approach is to price Medicare supplies in competitive auctions. That is not surprising. What is surprising is the degree of consensus that Medicare’s shift to auctions is fatally flawed and must be fixed for the Medicare auctions to succeed in lowering costs while maintaining quality for medical equipment and supplies.

For the last ten years, the Centers for Medicare and Medicaid Services has been testing an auction approach that is incredible in the inefficiency of its flawed design. This policy brief lays out a number of weaknesses with the auction procedure but it is sufficient to focus on the interaction of just two:

Bids are not binding commitments: "In the Medicare auction bidders are not bound by their bids. Any auction winner can decline to sign a supply contract following the auction. This undermines the credibility of bids and encourages low-ball bids in which the supplier acquires at no cost the option to sign a supply contract. This aspect of the current system has led to the predictable outcome where a number of bidders, realizing that prices were set below their costs, have refused to sign contracts."

Flawed median-bid pricing rule: As is standard in multi-unit procurement auctions, bids are sorted from lowest to highest, and winners are selected, lowest bid first, until the cumulative supply quantity equals the estimated demand. Non-standard is that the current system sets reimbursement prices using the median of the winning bids rather than using the clearing price. Since most providers are small, they lack the resources to invest in information and strategy in preparing bids. For them an effective and easy strategy is the low-ball bid, as any one firm’s impact on price is negligible. The low-ball bid is appealing to these firms because it is a winning bid with a negligible effect on the price. However, with many firms following this strategy the median-bid price is significantly biased downward and possibly below the cost of all suppliers...

"...Medicare should junk the flawed procurement auction rules and take advantage of the enormous advances that have been made in auctions and market design to fix the auction rules. “The appropriate bidding mechanism would arise from a collaboration of government officials, industry representatives, and auction experts,” wrote Peter and Brett Katzman in the policy brief mentioned above. “It would emphasize transparency, good price and assignment discovery, and strategic simplicity. The result would be sustainable long-term competition among suppliers that reduces costs while maintaining high quality.” This approach has been used with great success in other complex settings such as government auctions of radio spectrum and modern electricity markets...

"The mystery is why the government has failed over a period of more than ten years to engage auction experts in the design and testing of the Medicare auctions..."

To view the full post, click here.